California is trying partial deregulation

February 2, 1997

By Wayne T. Brough

The electric utility industry is undergoing
a major transformation that holds the promise
of cheaper electricity and expanded consumer
choice as we enter the 21st century.

Historically, the $200 billion industry has
been dominated by vertically integrated monopolies
with government-protected franchises. Consequently,
nobody shops for electricity; captive ratepayers
are forced to purchase electricity from their
local monopoly provider. As a result, the average
price of electricity is considerably higher
than the prices generated in a free and open
market for electricity.

Advances in both technology and economic theory
suggest that the current system of monopoly
providers is inefficient and should be reformed.
Introducing competitive reforms will free captive
ratepayers and provide opportunities for billions
of dollars in consumer savings.

Currently, electricity is provided by monopolists
under rate-of-return regulations that are written
by state public utility commissions. Interstate
and wholesale transactions are also governed
by the Federal Energy Regulatory Commission.
Although utilities are prohibited by law from
competing for one another's customers, the
utilities are connected to a grid that allows
power to flow freely from one region of the
country to another. The technology exists to
move power freely across the grid; regulatory
barriers are the only constraint.

The debate over restructuring the electric
utility industry has moved well beyond the drawing
board. The United States trails a number of
countries, but several states are moving forward
with plans to fundamentally change the way consumers
purchase electricity. California, along with
New York and Pennsylvania, is at the head of
the pack. In California, Jan. 1, 1998 has been
set for the target date when consumers will
have the ability to choose their provider of
electricity. From this date on, Californians
will have the opportunity to shop for lower
prices for electricity, much the same way they
choose their long-distance provider.

Why is customer choice important? A competitive
market provides substantial savings for all
classes of customers, including residential
consumers. Citizens for a Sound Economy Foundation
commissioned Professors Robert McCormick and
Michael Maloney of Clemson University to determine
the consumer benefits of competition. Their
findings are impressive.

Nationwide, the average price for a kilowatt-hour
of electricity is 6.9 cents. This translates
into an average residential bill of $69 per
month. In a competitive market, producers would
lower prices to eliminate any excess capacity
while using their facilities more efficiently.
For the residential customer, a more competitive
electricity market would yield $18 a month in
savings off the monthly bill, holding consumption
constant. In California, residential consumers
can save up to $16 a month in a competitive
market.

Over the long run, new technologies will emerge
that will make producing electricity even cheaper.
Gas-fired turbines are already coming on line
that can generate electricity for 3 cents per
kilowatt-hour. As these new technologies are
adopted consumers can save up to 43 percent.
For the average residential consumer, this would
translate into a savings of $30 off the monthly
bill of $69.

There are substantial savings for commercial
and industrial customers as well. As a whole,
the savings for all classes of customers throughout
the economy add up quickly. In fact, CSE Foundation's
study finds that consumer benefits would total
as much as $107 billion annually in an open
market for electricity.

Competition is also good for the economy. Because
electricity is an input into virtually every
good and service produced in the United States,
a fall in the price of electricity will have
wide-ranging benefits for the economy.

Professors McCormick and Maloney estimate that
removing regulatory barriers to competition
would increase the U.S. gross domestic product
by $19 billion annually. In addition, up to
3 million new jobs would be created due to cheaper
electricity. Removing electricity regulation
also would provide the equivalent of a 2.6 percent
reduction in the Producer Price Index, which
is similar to eliminating a year's worth of
inflation.

Comparing residential electrical
rates

Electricity costs vary
widely by region. Utilities in California
and Northeastern states that own nuclear
plants typically have the highest rates.
Northwest utilities can charge less
because they have access to cheap hydropower.
Many other factors such as state tax
levels and degree of regulation can
affect rates.
A sampling of average residential rates
in cents per kilowatt hour for investor-owned
utilities in 1996:

Despite the significant gains to the economy
from restructuring electric utilities, the actual
transition to a competitive market is often
contentious. Not all utilities are willing to
forego their current monopoly status. A protected
market with a guaranteed rate of return is preferably
to the uncertainties of the marketplace. Many
utilities are using the political market to
shore up the status quo rather than invest in
the resources necessary to compete in a competitive
market.

Utility

State

Cents/ kWh

Portland General ......................

OR

5.99

Alabama Power .......................

AL

6.84

Entergy New Orleans ...............

LA

7.24

Consumers Power ....................

MI

7.78

Houston Lighting & Power
.......

TX

8.25

Pennsylvania Power & Light
.....

PA

8.33

Massachusetts Electric .............

MA

10.56

Cleveland Electric ....................

OH

11.04

San Diego Gas & Elec
.............

CA

11.04

Public Service Electric &
Gas ....

NJ

11.71

Pacific Gas & Electric
...............

CA

12.07

Niagara-Mohawk Power ...........

NY

12.22

Southern California Edison
........

CA

12.54

Source: Edison Electric Institute

Perhaps the most important concern that utilities
raise is the inability to recoup their investments
in a competitive marketplace. Given the non-competitive
nature of the electricity industry, past investments
may been made that do not pass a market test.
In particular, some utilities have made costly
investments in nuclear facilities that cannot
be recovered in an open market. Utilities have
dubbed these investments stranded costs. In
fact, stranded costs should be viewed as a situation
in which the book value of a utility exceeds
its market value. In other words, investors
paid more for a plant than it is worth to any
potential buyer.

But, it is important to remember that stranded
costs are not new costs imposed by the marketplace.
These costs show up every month in every utility
customer's bill. Because regulation creates
captive ratepayers, utilities are able to recoup
their investments, whether they are good or
bad. Competition, however, will make it difficult
for utilities to charge consumers higher than
market rates to recover the costs of past investments
that cannot compete in an open market. Any attempts
to charge above market rates will send customers
scrambling to other providers.

Another tactic raised by opponents of a swift
move to competition is to frame the debate over
electricity as an effort by large industrial
users to obtain cheaper electricity at the expense
of smaller customers such as residential consumers
and small businesses. This is the "big
dogs eat first" argument. The problem with
this argument is that the big dogs are already
eating. Large users have the economic clout
to negotiate rock-bottom rates from their utilities.
And the threat of competition has led many utilities
to offer great deals to their industrial customers
in an attempt to lock them in before the markets
are fully opened. Unfortunately, these deals
are reserved for large customers only. Full
competition is necessary to provide the same
options to smaller customers.

At the other extreme, some have criticized
the move toward competition because it does
not go far enough. Electricity production has
three main components: generation, transmission,
and distribution. To date, discussions of restructuring
have focused mainly on deregulating generation,
with the assumption that the transmission and
distribution systems that bring the power to
your house will remain regulated. Without deregulating
transmission and distribution systems, some
argue that a portion of the monopoly still exists,
so consumers could still be overcharged.

While it is obvious that deregulation done
badly will yield poor results, it does not follow
that deregulating generation alone will not
provide consumer benefits. After all, generation
is typically the largest cost component in a
consumer's electric bill. Ultimately, opportunities
may arise to deregulate transmission and distribution.
Pennsylvania's move toward electricity restructuring,
for example, provides an opportunity to revisit
the remaining regulation in the near future.
But ignoring the potential for deregulating
generation alone is like dismissing a 20 percent
tax cut simply because the entire Internal Revenue
Service was not abolished.

This is not to make light of the difficulties
and potential dangers of the transition to a
competitive market. As California is learning,
writing the rules to a transition can be complex.
There is a significant danger that the transition
can be used to expand regulatory authority either
at the federal or state level. We are not in
a perfect world and there will still be regulated
elements in the electricity market. It is important,
therefore, that the transition follows the true
intent of reform: open competition and customer
choice.

The transition to a competitive economy will
require a review of state and federal jurisdiction
over the transmission and distribution of electricity.
In bringing cheaper electricity to consumers,
it is important to avoid unnecessarily expanding
the authority of FERC or other regulatory bodies.
The goal of restructuring is to introduce market
forces, not create new regulatory authority.

Introducing competition into the electricity
market is an idea whose time has come. The quicker
we move to competition, the quicker consumers
will save money. As we begin a new century,
it is time to eliminate the barriers to competition
that have built up over the last century. A
competitive electricity market saves money for
consumers, businesses, state and local governments,
and, ultimately, it provides for a stronger
and more competitive U.S. economy in the 21st
century.